The Wealth Problem


The Wealth Problem

Aspiring to own a home and pursue an education are quintessentially American ideals. It's time to make those dreams accessible again.

April 30, 2015

You may also like

This article appears in the Spring 2015 issue of The American Prospect magazine. Subscribe here.

Celebrate our 25th Anniversary with us by clicking here for a free download of this special issue.

The postwar boom was a time of broadly shared prosperity, when working- and middle-class people not only enjoyed steadily increasing incomes but were also able to accumulate lifetime wealth. The measures that made possible this wealth-broadening included expansion of homeownership under a reliable, well-governed system of mortgage finance; the development of a retirement system, with Social Security complemented by private pensions; debt-free higher education; and rising real wages. Each of these instruments interacted with the others.

Today, these mechanisms have all gone into reverse. Meanwhile, the capacity of the already-rich, the parentally endowed, and the well-situated to accumulate financial wealth has only intensified. Wealth inequality gets less attention than income inequality, but it is every bit as important. And the two are related. Wealth helps generate income and the capacity to earn income. Decent income increases the capacity to save and to amass wealth. As public systems for wealth-broadening collapse, private wealth within families provides asset endowments to the young and positions the next generation to become upper-income earners like their parents.

Economist Thomas Piketty called overdue attention to wealth extremes in his celebrated book, Capital in the Twenty-First Century. Assembling more than two centuries of data from several countries, Piketty demonstrated something close to an iron law of capitalism: The return on capital tends to exceed the rate of GDP growth. Thus, as a matter of simple arithmetic, wealth becomes ever more concentrated. But the most interesting and least developed part of Piketty’s book was his discussion of the mid-20th century—an anomalous period when wealth and income became more equal.

Piketty—more of a virtuoso historical statistician than a political economist—attributed this temporary reversal primarily to accidental and mechanical factors, most importantly the fact that a lot of wealth (largely owned by the wealthy) got wiped out in two world wars and the Great Depression. Thus, wealth distribution became more equal. But that weakening of concentrated capital had political implications. It opened the door to a different constellation of power and to more egalitarian social contracts in the major democracies.

In the United States, policies were put in place that promoted wealth building for the middle and working classes. Now, 70 years later, those policies are eroded and the capital-owning class once again enjoys concentrated wealth and the power that goes with it. What policies might restore balance?

Interestingly, in the early postwar era there was no explicit policy goal or field of inquiry called wealth-building. Rather, egalitarian policies in different realms broadened wealth in several mutually reinforcing respects.

A pension provided secure retirement in old age. Financial assets in pension funds were not under the direct control of the pensioner but were held on his (and occasionally her) behalf, and spun off income that was contractually guaranteed. Many pensions also extended to widows. Some critics contended that pensions made it too easy for people to neglect individual savings, but research suggests that the institutionalization of retirement via public and private pension systems has the opposite effect. If you expect to retire, you are more likely to plan for retirement. You become aware that a pension may not be sufficient to maintain your standard of living. By focusing attention on retirement as a social institution, the pension system actually encourages complementary personal savings. In line with that evidence, personal savings rates rose during the postwar boom; they declined only when incomes, job security, and free higher education began collapsing.

Rising real wages made supplemental savings possible. Working- and middle-class families were not spending every nickel of income making ends meet. They had discretionary income to save. (The memory of the Great Depression probably helped promote the savings habit, too.)

(AP Photo/The Record (Bergen County), Marko Georgiev)

College student Frangy Pozo, 19, holds a banner at a "Tear Up Your Debt" demonstration, during which students tear up mock tuition bills and loan papers to protest rising student loan debt, on Wednesday, October 17, 2012, in New Brunswick, New Jersey. 

Debt-free college for the vast majority allowed some portion of discretionary income to flow to savings rather than paying off debt accumulated before full-time employment even began. The need to pay off college loans not only depresses the capacity to save but also delays or prevents the purchase of a house, diminishing another form of lifetime wealth accumulation.

Progressive taxation provided the resources for public funding of such programs. Tax cuts deplete resources for wealth-broadening programs. State governments, however, now provide less than 15 percent of the funds for state universities, forcing students and their parents to bear an increased share of the cost. Failure to adequately fund public pensions for state and municipal employees has left such pensions at a tipping point where they are losing both broad public support and solvency.

Homeownership became the single most important source of asset accumulation over the life cycle. For the first two postwar generations, housing values rose faster than inflation. For tens of millions of lucky homeowners of that era, the “equity” created by the windfall of increasing real estate prices exceeded the equity created by paying off the mortgage.

The policy area now known as “asset development,” funded by foundations and promoted by several advocacy groups and occasionally by government, dates only to the late 1980s. It became a public concern and a policy goal when earlier wealth-broadening policies began to peter out, and as part of the perception that the wealth benefits of the postwar boom had excluded many poor people and minorities. The policy ideas that now parade under the asset-development banner offer a clue to how we might go about restoring wealth accumulation for the working and middle classes.

The political challenge, however, is that the redistributive policies of the postwar era were tacit. Aspiring to own a home and pursuing an education were and are quintessentially American ideals, more conservative than radical. Social Security quickly became accepted as a mainstream American institution as well. None were promoted as redistribution per se. As candidate Barack Obama discovered in his 2008 campaign exchange with Joe the Plumber, it is harder to sell policies explicitly packaged as spreading the wealth around.

Wealth Accumulation and the Long Housing Boom

Homeownership is a logical place to start because it is the single most important source of wealth-broadening. Broadly held property wealth, initially rooted in the yeoman farmer, has a long American pedigree that goes back to Thomas Jefferson and beyond. Since the financial collapse of 2008, some critics have argued that as a society we place too much faith in homeownership and that we “over-subsidize housing.” The critics are right that too much of the subsidy goes to further enriching the rich, but that mix could be shifted. The goal of broad homeownership remains valid, both for its own sake and as a source of lifetime wealth building.

Critics of the package of incentives for homeownership that began in the New Deal often overlook the fact that the ideal of a broad, property-owning democracy is deeply American. The Homestead Acts beginning in 1862 produced homeownership (family farms) rates as high as 75 percent in some of the newer states of the Midwest and Northwest. Before the Homestead Acts, Jefferson called for a republic of small freeholders as the social basis for republicanism, and his land-tenure policies deliberately favored owner-occupant farmers over large speculators. More than a century before Jefferson, the Massachusetts Charter offered a deliberate model of broad property ownership, based on carving the Commonwealth into townships designed for small farmers, complete with common schools and town meetings. Massachusetts is a deep blue state today because its political culture has been egalitarian for more than three centuries, in contrast to the states of the old South, which had quasi-feudal systems of land tenure quite apart from the complication of slavery. So there is more to the value of owner-occupied housing than just wealth-broadening.

And speaking of slavery, one of the legacies of slavery and segregation was that blacks had a much harder time than whites getting on the homeownership ladder. The “40 acres and a mule” promised as part of Reconstruction never materialized. In the North, blacks were victimized by the contract-sales system, which excluded many from standard mortgage finance. Instead, African Americans who aspired to own homes were compelled to rely on a form of credit that accumulated no equity and no ownership until the debt was paid in full. You could faithfully pay on the sales contract for ten years and lose everything you had put in if you were late on a single payment.

Even the Federal Housing Administration deliberately enforced policies of racial exclusion. Not until the late 1960s did the federal government become a sometime friend of black homeownership—but often in the context of FHA-enabled realtor blockbusting, which only fueled racial tensions and discouraged stable, racially mixed neighborhoods. The government-abetted subprime debacle—a catastrophe of wealth destruction in black communities—is only the latest chapter in a disgraceful saga. The gross disparity of black wealth and white wealth (which has worsened since 2006) is in part a function of depressed black homeownership rates.

Because of foreclosures during the Great Depression, homeownership rates had fallen to around 40 percent at their nadir in the late 1930s. The mix of the New Deal housing-finance programs and rising real incomes combined with cheap land prices and the interstate highway system increased that rate to about 64 percent by the mid-1960s. City dwellers could acquire suburban homes for less than the cost of rent. But recently, homeownership rates have come back down from a peak of over 69 percent to under 64 percent.

Homeownership during the postwar boom allowed people of modest means to accumulate real financial assets. The combination of rising incomes, memories of Depression hardship, and strict government regulation meant that borrowing against one’s home to subsidize current consumption was off-limits for that generation. There was no such thing as a home equity loan or a home equity line of credit; if people did refinance, it was usually to pay for home improvements. In the disinflation of the 1990s that followed the inflation of the 1970s and early 1980s, people refinanced to take advantage of falling interest rates on mortgages. But it was only in the 1990s and the 2000s that it became common to “take out equity” to pay for current consumption in the context of stagnant or declining wages and rising college tuitions. Thus did three trends—bad housing policy, wage stagnation, and debt-financed education—combine to strip middle-class financial assets.

Did We Rely Too Much on Housing to Build Wealth?

Since the subprime debacle caused a housing bubble followed by a collapse, we have seen an intriguing debate in which many critics contend that we put too many eggs in the housing basket. Interestingly, one can find these critics left, right, and center. The argument comes in three parts.

First, even if housing was once a source of easy wealth accumulation, the windfall years are over. In the 1950s and 1960s, housing values rose slightly faster than inflation as real estate development bid up land prices. In the more serious inflation of the 1970s and 1980s, people deliberately put their money into housing where it was likely to hold its value. That bid up real estate prices even further. In the 1990s, as inflation and interest rates subsided, cheap money was capitalized into higher asset values: The low rates on mortgages meant that people could afford more expensive homes, and demand pushed up prices yet again.

Owners who sold the family home in that era gained far more from inflation than from amortization. But by the early 2000s, the end of cheap land and housing inflation itself had driven up prices to the point where they outstripped incomes. People observed that they could not afford to purchase the homes in which they lived. In most metro areas, the median-priced house far exceeded the purchase capacity of the median income. Many economists accurately warned of a bubble.

Dean Baker of the Center for Economic and Policy Research, putting his money where his mouth was, sold the family home and moved into a rental.

The subprime scam tried to disguise the unaffordability of housing with very low-rate “teaser” loans that reset after a few years. Lenders and purchasers bet that prices would keep appreciating so that the loans could be refinanced or the house sold before the interest rate rose. But obviously, if the median-income household in most metropolitan areas cannot afford the median-priced house, prices will not continue to appreciate faster than inflation. The bubble was destined to burst. The subprime collapse caused prices to fall back to earth, abruptly but very unevenly. Even for those whose mortgages are not underwater, housing is no longer a sure bet to hold its value. That psychology itself dissuades many potential buyers, thus moderating housing demand and housing inflation. So it is very unlikely that future generations will enjoy the windfall appreciation captured by their parents and grandparents.

Economist Robert Shiller argues that the inflation-adjusted appreciation in housing prices from 1890 to 1990 was about zero and the boom after World War II was an anomaly. He contends people would be better off investing in the stock market. In an article in the libertarian magazine The Week, Ryan Cooper describes homeownership as a “malignant symbol of the American Dream” that should “die a quick, quiet death.”

A second reason to be skeptical of housing as a financial asset, say critics such as economist Baker, is that a house is a poor investment for Americans who move around a lot. “The high transactions costs associated with buying and selling a home mean that anyone who does not stay in a home for a substantial period of time is likely to end up losing as a result of owning rather than renting.” Baker is right, of course, but that still leaves a lot of people who could benefit from homeownership. (After the bubble burst, Baker bought back in as a homeowner again, and has probably done well as real estate values have stabilized and resumed rising.)

Despite the widespread assumption that the new economy and the end of the lifetime job have produced higher rates of mobility, the Census Bureau reports that increased rootlessness is a myth. In fact, the rate of annual mobility has steadily declined from a modern peak of 20 percent in 1985 to under 12 percent in 2011, and has ticked up only slightly since then.

Third, many argue, if we want to promote accumulation of wealth, it’s time to de-link that goal from homeownership and promote the acquisition of financial assets directly. Richard Florida points to the fact that many rich nations with income and wealth distributions more equal than ours have lower rates of homeownership, including Switzerland, Germany, and New Zealand, and few subsidize homeownership as much as we do. People, Florida reports, are less likely to own their own homes as nations become richer. Egalitarian Europe relies on other measures to promote greater equality.

There is surely a case for developing other measures to broaden wealth, of which more in a moment. Even so, there is a lot to be said for promoting homeownership both for its own sake and as a means to wealth accumulation for people of modest means.

Let’s assume no more windfalls. Even if a home appreciates only at the rate of inflation, after 30 years the family will own an asset worth several times its annual income. A house combines the “use value” of having a place to live with the financial value of accumulating wealth. There is no use value in a 401(k) plan. Economists like to point out that homeowners get the benefit of the value of “imputed rent.” Sending in a monthly check that accumulates equity still beats sending that check to a landlord. In principle, Shiller may be right that people, over a lifetime, would be better off in the stock market. But in practice, few young adults can afford both a monthly rent check and a monthly payment to a nest egg. A mortgage payment achieves both.

Victor Juhasz

The fact that the financial-industry sharks who came up with subprime lending managed to spoil the dream of owning your own home for much of a generation is not a good reason to give up on homeownership as a national policy goal. On the contrary, it’s a reason to retool housing policy to make it possible for the young to aspire to the dream once again. We need strict controls on the practice of turning mortgages into securities. Ideally, we should re-create the original secondary mortgage market of the era when Fannie Mae (before 1969) was a public institution, and there were no exotic “private-label” mortgage-backed securities, no scandals, no bubbles, and hardly any losses. 

Yet, as desirable as homeownership is, the critics are right that we should not limit our efforts to housing. According to a study by the Urban-Brookings Tax Policy Center, the government spends about $300 billion a year on wealth accumulation subsidies, via the tax code. Most of that goes to housing tax deductions and to tax-sheltered retirement benefits, and all of that is tilted toward the upper brackets. The third-largest category is favorable tax treatment of capital gains, which is even more tilted to the rich. If we spent those funds differently, we could help the non-rich accumulate wealth.

For starters, we could limit and reprogram the mortgage interest deduction. Canada and Australia no longer allow tax deductions for mortgage interest, and have suffered no reduction in rates of homeownership. Cutting that subsidy (which gets capitalized in the value of the house) would also restrain bubble effects of low mortgage interest rates. Repealing that tax break outright would be a very hard sell, but we might cap it at the value of a median-priced home in any given metro area.

Suppose we redirected $250 billion of that tax subsidy a year. That would leave $50 billion a year in the housing sector to subsidize first-time homeownership for moderate-income households, either though down-payment subsidies or mortgage interest subsidies with caps. The mortgage interest tax deduction is almost useless for the bottom 50 percent of homeowners, who tend to take the standard deduction.

A retirement system aimed at broadening wealth would be a good place to start. It’s not enough, however, to have a more portable system of 401(k)-style savings, as many conservatives propose, because lower-income people can’t afford to put in enough money. Whereas Social Security is deliberately redistributive, tax-favored individual savings accounts such as IRAs, Keoghs, and 401(k)s mirror the unequal distribution of wage and salary income. They leave lower-income workers with insufficient savings for retirement. In addition to workers and employers putting money into a retirement system, government could inject direct subsidies as an explicit strategy of wealth-broadening. (Elsewhere in this issue, Teresa Ghilarducci describes the mechanics of a universal and adequate retirement system.)

Spreading the Wealth Around

This brings us to explicit systems of wealth-broadening. As noted, this presents a tougher politics. In “asset development” circles, advocates have placed a lot of faith in Individual Development Accounts (first proposed by Michael Sherraden in 1991) and other subsidized forms of individual savings intended to demonstrate that even the poor are capable of saving and to cultivate the habit. At least 27 states have implemented some version of IDAs. But there are two big problems. First, at the current scale, this strategy is not sufficiently redistributive to make much of a difference. Second, the idea has never been able to get serious political traction. Programs come and go, they demonstrate moderate promise, and then are never taken to scale.

One interesting proof-of-concept is the phenomenon of remittances. Immigrants, among the poorest of workers in the United States, send surprisingly large sums to their families (with no subsidies or tax credits, thank you). Some very poor nations, such as Haiti, rely on remittances for about 22 percent of their GDP. So desperately poor people are unquestionably capable of saving, in this case to help even more desperately poor people back home. The question is whether this form of self-exploitation of the poor should be seen as an attractive social model.

One universal version of the strategy of a savings subsidy is what the British call “baby bonds.” The basic idea is that government sets up a savings account when a baby is born. Periodically, the government contributes to the account, and parents get a tax break if they add to the savings. The subsidy is tilted downward. In some versions, the funds are available to the beneficiary at age 18 or 21. In other versions, they may be withdrawn for approved uses, such as home purchases, starting a business, or retirement. This idea was a favorite of New Labour, and a modest form of it was enacted by the Blair government in January 2005, with each child getting an initial savings voucher worth 250 pounds. The scheme was repealed in 2010 by the incoming Tory-led government.

It would be a shame to have a scheme of wealth endowments at birth only to have all the money and more consumed by tuition payments. Restoring debt-free public higher education could be done in a number of ways. Taxes could be raised on the wealthy, and the federal government could create an incentive plan to match state spending on public universities to encourage states to follow suit. Plans for debt-free higher education financed by a surcharge on the income tax are more progressive than the current system, but they still amount to a kind of debt. They can be made less onerous if combined with a general subsidy. Another promising idea is debt forgiveness in exchange for national service. But genuinely free public higher education is the best idea of all.

A far more robust variant of the baby-bond approach has been proposed by two American social scientists, Darrick Hamilton and William Darity Jr. They envision a wealth endowment program for roughly the bottom three-quarters of the income distribution, with initial accounts of between $20,000 and $60,000 per child, which would double or triple by the time the child turned 18, depending on the rate of return. The program would cost about $60 billion a year, or about one-fifth of the subsidies currently spent on wealth accumulation (which is now tilted to the top).

An even more radical version of this general idea entails giving all citizens a stake in the capital part of our capitalist economy, and not just via subsidized or tax-favored individual savings accounts. This idea has been around since Henry George (who wanted to tax unearned appreciation in the value of land); and before him, since Thomas Paine, who proposed that every 21-year-old man and woman receive 15 pounds, financed from inheritance tax. In With Liberty and Dividends for All, Peter Barnes cites the Alaska Permanent Fund (which gives every Alaskan a share of oil profits) as the germ of a broader idea for giving everyone a stake in the financial wealth generated by the commons.

From the conservative populist side of the spectrum, Louis Kelso promoted the idea of a “second stream” of income for workers, based on shares in the profits of their employers. Kelso sold the idea to Senator Russell Long, and the Kelso plan was domesticated into tax-favored Employee Stock Ownership Plans, or ESOPs. For the most part, ESOPs have been used less by workers than by capitalists, as tax-sheltered forms of financing. Only a relative handful have resulted in genuinely worker-controlled or -owned companies.

With more and more corporations relying on contingent or “distributed” workers, the promise of worker ownership of stable firms has mutated into the precarious gig economy. A task rabbit or Uber driver is a kind of worker-entrepreneur, but not the sort who is likely to accumulate wealth. Nobody has even deigned to ask the newly rich owners of Uber to share their vast stock-market windfall with drivers, who are not even employees.

An intriguing question is whether the task-rabbit economy could coexist with new forms of profit-sharing, as a partial remedy for the insecurity. Uber drivers, after all, take the risks of petty entrepreneurs, but the owners get all the upside gain in the value of Uber shares. Modest profit-sharing has been used in the U.S. by some corporations since the late 19th century. The practice went into eclipse with the Great Depression, and never recovered except via the very limited success of ESOPs. Enthusiasts of the worker-owned corporation, such as Joseph Blasi, Chris Mackin, and Richard Freeman, believe this is the moment for a broad rebirth.

Four decades ago, an influential Swedish trade union economist, Rudolf Meidner, proposed a wealth-broadening plan that would have transferred a growing share of the wealth in the Swedish stock market to the citizenry. Meidner, one of the architects of the Swedish welfare state, proposed that corporations issue new shares every year equal to 20 percent of their profits, to capitalize and then gradually increase the value of the funds. Over time, workers would, through these funds, own the majority share in a still-capitalist economy. There was nothing wrong with the plan technically, but it provoked a huge political outcry, and that was back in an era when trade unions had more influence than they do today. The Social Democratic government briefly approved a version of the plan in the early 1980s, but it was quickly killed when a conservative government took power.

Here at home, Ta-Nehisi Coates, in a widely read essay in The Atlantic, has revived the radical idea of reparations for the descendants of slaves. One can debate whether wealth transfers to African Americans ought to take priority over wealth-broadening measures for all Americans, but there is no shortage of possible mechanisms.

Any of these approaches could broaden wealth and they deserve to be on the agenda. I particularly like the baby-bond idea, financed by taxes on the wealthy, to make explicit the idea of sharing the patrimony that’s now available only to the children of the rich. I also like Barnes’s notion of finding other forms of wealth generated by the commons and giving everyone a dividend in it. But these ideas are more exotic than good old homeownership and good old free public education, not to mention the norm that wages should rise with productivity. Those ideals, once so familiar that we didn’t give them a second thought, are still the low-hanging fruit of this debate.

Even so, the wealth gap is now so extreme that circumstances require us to make explicit what was once tacit. Wealth-broadening, with the right leadership and narrative, can become good politics. Young adults in particular should welcome national policies, in housing, education, earnings, and asset-building, that could made it as feasible for them to accumulate lifetime wealth as their parents and grandparents once did—not through heroic self-sacrifice but simply through playing by the rules. It’s the rules that need changing.